TAILIEUCHUNG - The Puzzle of Brazil's High Interest Rates

What is wrong is that adding money, in this case the medium of exchange function, to a model when it is not required leads only to counterintuitive results. Wallace’s proposal to add unit of account endowments to the Arrow-Debreu model to explain the role of a central bank in determining the price level is another example. The simple fact is that appending some or all of the functions of money to the Arrow- Debreu economy leads to counter intuitive results because the functions of money are not required and if appended to the model are inessential additions in the sense of. | The Puzzle of Brazil s High Interest Rates Alex Segura-Ubiergo INTERNATIONAL MONETARY FUND 2012 International Monetary Fund WP 12 62 IMF Working Paper Western Hemisphere Department The Puzzle of Brazil s High Interest Rates Prepared by Alex Segura-Ubiergo Authorized for distribution by Vikram Haksar February 2012 This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author s and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author s and are published to elicit comments and to further debate. Abstract This paper highlights that real interest rates in Brazil have declined substantially over time but are still well above the average of emerging market inflation targeting regimes. The adoption of an inflation-targeting regime and better economic fundamentals reduction in inflation volatility and improvements in the fiscal and external positions has helped Brazil sustain significantly lower real interest rates than in the past. Going forward the paper shows that Brazil can converge towards lower equilibrium real interest rates if domestic savings increase to the level of other emerging market countries. The effect is particularly pronounced if the increase in domestic savings is achieved through higher levels of public savings. Still econometric results suggest that controlling for everything else in the model real interest rates in Brazil are about two full percentage points higher than in other countries in the sample suggesting that there are still Brazil-specific factors that have not been captured by the empirical analysis. Some of these factors may include credit market segmentation and inflation inertia generated by still pervasive indexation practices. JEL Classification Numbers E42 E43 E52 C23. Keywords Brazil interest rates fiscal policy domestic savings Author s E-Mail Address aseguraubiergo@ The author

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